09 Nov 2020

Directors’ Liability in Cases of Bankruptcy Under UAE Law

Authored by: Ahmed Hadeed

In Brief:

Directors have potential liability in cases of bankruptcy.

Directors must be aware of their statutory obligations. For example, directors are obliged to:

  1. call for a general meeting if losses exceed half the share capital;
  2. keep proper books and records; and
  3. avoid wrongful trading.

Background

A company is an artificial person which is entitled to trade and enter into contractual obligations in similar manner to natural persons. Individuals can be punished if they breach the law; whereas a company cannot be subjected to physical punishment if a crime is committed.

Because a company is an artificial person, natural persons always act on its behalf. Prime among such natural persons are the directors of the company, who may be held liable for its violations.

Insolvency is, in essence, the condition of being unable to pay debts as they fall due. Insolvency is not an offence. However, the law prohibits certain acts and omissions to the extent that they lead to insolvency. A director should be fully aware of such acts and omissions so as to avoid potential serious consequences.

Call for a general meeting if losses exceed half the share capital

Under the UAE Companies Law (Federal Law (2) of 2015 Concerning Commercial Companies), directors have a statutory obligation to invite the general assembly to convene in the event that the company suffers losses that exceed the amount of half its share capital.

The purpose of the general assembly meeting is to allow the shareholders to determine whether the company should continue its business notwithstanding the losses, or the company should file for liquidation and be dissolved.

It is worth noting that the Companies Law does not specify a minimum share capital for a limited liability company. Theoretically, a limited liability company can be incorporated with one dirham share capital. However, practice in the UAE tends towards higher minimum share capital and limited liability companies operating in specific sectors (e.g. financial services) may be required to maintain a particular minimum amount.

Accordingly, if a limited liability company with a share capital of one hundred thousand dirhams and assets valued at millions in a given financial year makes losses of fifty thousand dirhams, director(s) of the company have a statutory obligation to call for a general meeting in order to request the shareholders to consider whether the company should file for liquidation.

What if the directors do not call for a general meeting?

Breaching a statutory obligation under the Companies Law is an offence. Furthermore, under the UAE Bankruptcy Law (Federal Decree Law (9) of 2016 Concerning Bankruptcy) breaching a statutory obligation under the Companies Law that leads to the bankruptcy of a company can cause the director(s) of that company to be required to contribute to the company’s debts in certain circumstances.

Keep proper books and records

Maintaining proper and accurate books of accounts and financial records is a statutory duty imposed on the directors of a commercial company. Breaching this duty may trigger criminal as well as civil liability.

The UAE Commercial Law (Federal Law (18) of 1993 Concerning the Issuance of Commercial Transactions Law) and the UAE Companies Law impose statutory obligations on a commercial company to maintain proper and accurate books of accounts and financial records.

If this duty is not complied with and the company is declared bankrupt, the directors may incur a criminal penalty under the UAE Bankruptcy Law. 

Wrongful trading

Wrongful trading occurs when a company continues to carry on its business thereby trading when insolvent. Once the directors of a company knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent administration, they have a duty to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors.

Continuing to trade while insolvent thereby causing losses to creditors, in the sense of wrongful trading as described above, is illegal in a number of jurisdictions (e.g. England).

Is it unlawful under the UAE Bankruptcy Law for directors to continue trading while knowing that the company’s bankruptcy is unavoidable?

There is no express provision in the UAE Bankruptcy Law specifying that it is illegal to continue to trade in a situation where there is no reasonable prospect that the company would avoid bankruptcy.

Article 68 of the UAE Bankruptcy Law (Bankruptcy Procedures Application) imposes an obligation on the debtor to file a bankruptcy procedures application, if the debtor ceases to pay its debts as they fall due for 30 consecutive working days, or if the debtor’s liabilities exceed its assets [1].

Article 157 (Forfeiting the Management and Disposition Rights) prohibits the debtor from managing or disposing of its assets as of the date of the court decision to commence the restructuring or the bankruptcy procedures under the Fourth Section of the Bankruptcy Law. 

It can be inferred from Articles 68 and 157 that a debtor must stop trading once there is no reasonable prospect of avoiding bankruptcy, because the debtor has to file a bankruptcy procedures application if it ceases to pay its debts as they fall due for 30 consecutive working days or if the debtor’s liabilities exceed its assets and, as a result of this application, restructuring or bankruptcy procedures commence which in turn lead to forfeiture of management powers.

Furthermore, Articles 201-5 impose a penalty on the director of a company, in circumstances where the company has been declared bankrupt by a final judgment, and had transacted in a manner detrimental to the interests of creditors for the purpose of avoiding or delaying reaching the position where the company is no longer able to pay its debts as they fall due for 30 consecutive working days.

This means that once the directors of a company knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent administration, any further trading is conducted at the risk of detriment to the interests of creditors for the purpose of avoiding or delaying reaching an insolvent position, unless such trading was conducted for the sole purpose of reducing the losses of the creditors.

Recommendation

Under current market conditions, which are overwhelmed by the effects of COVID-19 repercussions, it is very important that directors be fully aware of their statutory obligations, especially those obligations which, if not complied with, could give rise to serious liability in case of bankruptcy.

It is very important that directors maintain accurate books of accounts and financial records, and invite the general assembly to convene if losses exceed half the capital of the company.

Directors should be aware of acts and omissions that may give rise to wrongful trading. In some situations, this might be a gray area. Accordingly, it is highly recommended that directors appoint legal advisors with knowledge and experience of the UAE Bankruptcy Law when such circumstances arise. 

Should you have any query or require further information, please feel free to contact Ahmed Hadeed, Partner, Abu Dhabi A.Nasser@hadefpartners.com


[1] The UAE Cabinet has recently announced that it has approved a draft federal law providing for the amendment of certain provisions of the UAE Bankruptcy law. This obligation under Article 68 is expected to be suspended in an ‘emergency case’ under such draft federal law. The COVID-19 situation is expected to qualify as an ‘emergency case’ under this new law.

 
 

This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the developing jurisdiction of the UAE.